A New Look at Adequacy of Retirement Income

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A New Look at Adequacy of Retirement Income

• Session 403
• Tuesday March 28, 2006
• 2006 Enrolled Actuaries
• Bruce E Palmer ASA, MAAA, CLU, ChFC

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Headlines

• A Lost Retirement Dream for Boomers?
• Washington Post December 7, 2003
• Retirement Blues Youve done the hard work and
  managed to retire with a nest egg. The trick now
  is to not outlive it.
• Contingencies Sept/Oct 2003

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More Recent Headlines

• Accounting Overhaul May Hurt Pensions
• Associated press January 17, 2006
• Proposed adjustments to Pensions and Other
  Post-Retirement Employee Benefits would more than
  eliminate the book value of Goodyear Tire and
  Rubber, UST Inc, General Motors, Navistar, and
  Ford.
• Pension Upheavals May Threaten Nest
  Eggs Associated Press January 16, 2006
• IBM freezes its pension program.
• Can people still count on retirement funded by
• pensions and Social Security?

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More Recent Headlines

• How Safe is Your Pension?
• Wall Street Journal January 14, 2004
• IBMs announcement to freeze its pension sent a
  chill through workplaces. This hard freeze is
  similar to an employee changing jobs.

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US News Stories in 2005

• Filled with stories of troubled pension plans and
  concern for entire defined benefit system.
• Most stories focused on specific pension plans in
  already troubled industries.
• Overall pension funding deficit has improved
  200 Billion in 2003 dropping to 137 billion in
  2005
• Majority of pension risk involves the airlines
  and automakers.

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What do the experts say?

• Watson Wyatt measures an employers risk from a
  pension plan as Pension Risk Index (PRI).
• Most Fortune 1000 companies have PRI lt1 posing
  little risk to financial health.
• Most companies with a significant level of
  pension risk are on solid financial ground,
  likely to weather a crisis
• Investment mix is shifting to lessen risk.

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Is There Good News?

• The Good News
• We are living longer lower mortality risk
• The Bad News
• We are living longer higher longevity risk
• The Good News
• There are improvements in Health Care
• The Bad News
• Those improvements cost more

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What should I expect in retirement?

• Health care costs increase every year. How will
  it be different when I retire?
• Inflation for retirees is higher.
• People live longer. What should I expect?
• Social Security. Effect of changes
• Company Insolvencies (pre or post-retirement?)
• What are my sources of Income?

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Per Capita Medical Inflation
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Purchasing Power of the Dollar

• Decreased 51 during the 1970s
• 39 during the 1980s
• 25 during the 1990s

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Consumer Price Index

• CPI-E, a consumer price index tracks the cost of
  living for those 62 and over.
• CPI-W is the one we normally hear about.
• CPI-E rises faster than CPI-W.
• Social Security increases are based upon CPI-W.

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Why Retirement Security is at Risk

• Americans are living longer
• Americans are spending more time in retirement
• The traditional pension check is becoming a thing
  of the past
• Social Security is not enough
• Even careful savers have limited control over
  their future.
• Source Americans for Secure Retirement

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Income Sources in Retirement

• Continued Employment
• Wealth at Retirement
• Pension
• Savings
• Social Security

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Percent of Workers with Defined Benefit vs.
Defined Contribution Pension Plans
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Life Expectancies

• As life expectancies extend, fears rise as to
  whether income will continue throughout lifetime.
• Estimates of average life expectancies can be
  predicted fairly accurately but not so with
  individuals.
• Life expectancy varies by gender.

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Life Expectancies

• In 1940 a male age 65 could expect to live 12.5
  yrs, by 2004 it was 16.5 years, 32 longer.
• Currently we marvel when someone celebrates their
  100th birthday, but many Americans live into
  their 80s and 90s

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Average Life Expectancies of Men and Women
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Social Security Review

• Retire at normal retirement age with average
  earnings receive about 41 of prior years
  earnings.
• At NRA with max earnings get about 25.
• For DOB lt 1938 NRA is 65 and will increase to 67
  for DOB gt 1959.
• Early retirement from NRA 65 to age 62 has
  reduction of 20
• Early retirement from NRA 67 to age 62 has
  reduction of 30

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Special Gender Challenges

• Women tend to live longer
• During their working years women
• Earn less
• Have fewer full-time years employed
• Social Security spousal supplement
• In one-earner families the non-employed spouse
  receives about half the workers benefit raising
  the combined total from 41 to 62. At death the
  benefit is about the larger of the two or 41...
  Down by 33
• For two equal earners, both get 41 or 41 of
  combined income. But at death it is back to 41
  of one income or 21 of pre-retirement income.

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Example of Spousal Supplement

• Spouse A Benefit Spouse B Benefit
• One Earner family
• 2000 0 (very small)
• 1000 spousal supp
• At first death the benefit to survivor is the
  larger or 2000
• Two equal earner family
• 1000 1000
• At first death the benefit to survivor is the
  larger or 1000
• Less survivor income to the two earner family
• Single person
• 2000 no chance of supplement

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Example of Spousal Supplement(2000 earned
Benefit Assumed)

• Family Spouse A Spouse B B SP B
  Survivor Survivor
• earners Benefit Benefit Supp
  Benefit Basis
• One 2000 0 1000
  2000 Larger
• Two 1000 1000 0
  1000 Larger
• Single 2000 None n/a

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Sources of Wealth at Retirement

• The average US household
• 46 from Social Security
• 39 from personal savings
• 14 from pensions

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Source of Wealth at Retirement
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Planned Age of Retirement

• Household Characteristics
• Retire before age 62 young with high income and
  higher net worth than at 65
• Retire before age 65
• Have Defined Benefit Plans
• Have rules to save including for retirement
• Expect their retirement income to be sufficient
• See themselves as fortunate

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Soc Security effect upon Retirement Age

• Planned retirement age?
• Less than 20 before age 56
• 35 by age 61
• 48 by age 62 when Soc Sec first available
• 51 by age 64
• 86 by age 65

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Changes in Soc Security

• Baby Boomers are coming. In 2000 there were 35
  million Americans 65 or older, 12 of population.
• By 2030 that will double to 70 million, or 20
• Financing or benefit changes need to be expected.
  The current pay as you go system wont hold up.

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Providing Income Throughout Life

• Level annuity.
• Mix of 25 level annuity and 75 fund investment.
• 25 variable annuity and 75 fund.
• 25 each in level and variable annuities and 50
  in fund.
• Inflation-indexed annuity backed by TIPS
  (Treasury Inflation Protected Securities)

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An increasing annuity can preserve purchasing
power
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Conclusions

• Already scheduled changes in the Soc Sec law will
  cause substantial reductions from todays income
  level relative to earnings. Future changes are
  not likely to improve that.
• The American worker needs to learn to save more
  and start sooner
• Annuities can guarantee a lifetime income, but
  they need to be indexed to inflation or dollars
  set aside early on to cover later needs.

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Retirement Plan Features to Consider

• Allow partial annuitization for guaranteed income
• Allow partial lump sum withdrawals
• Minimum benefits based upon final ave pay for
  late career hires
• Phased retirement for partial benefits while
  working part time
• Provide annuity options under 401(k)
• Flexibility to fund medical benefits during
  retirement
• Cash Balance Plans
• Use pay credits that increase with Age and/or
  Service
• Allow directed investment credits
• Provide access to planning and projection tools
  to use with flexible payment schedules during
  partial retirement